Mexico Has Stamina to Maintain Energy Reform

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Despite low oil prices and political challenges faced by the Mexican President Enrique Pena Nieto’s government, Mexico possesses the stamina to fully implement reform of its energy sector. However, Mexico may need to show more flexibility in its requirements to encourage the oil and gas investment it seeks, according to an expert on Mexican energy policy.

The nation is 100 percent and unequivocally committed to the process of energy reform, said Duncan Wood, director of the Mexican Institute at the Woodrow Wilson International Center for Scholars, at a Jan. 14 seminar on Mexico energy reform hosted by law firm Mayer Brown LLP. However, the bidding terms proposed for Round One have worried some oil and gas firms, and Mexico could benefit from slowing down the process to get the “pristine” response it wants for its bidding round and to secure Pena Nieto’s legacy.

Late last year, the Mexican National Hydrocarbons Commission (CNH) published the model for the first phase of Mexico’s Round One bid process for 14 shallow water contract areas ranging in size from 116 square kilometers to 501 square kilometers. The shallow water acreage is one of five types of licenses being offered in Round One. Announced in August 2014, Round One will include 109 exploration blocks and 60 production blocks. Secretaria de Energia de Mexico (SENER’s) tentative Round One timeline included staggered bidding invitation and data room access for shallow water exploration, production, onshore, unconventionals and the Chicontepec Basin and deepwater.

“Mexico has done the hard work, but the process needs to be tweaked,” Wood told seminar attendees.

To put things in perspective, the speed and ambition of the reform process has been impressive, said Wood. In fact, the energy reform implemented is even more aggressive than reform proposed by Pena Nieto in August 2013. To win the Partida Accion Nacional political party over, Pena Nieto had to agree to go further with energy reform. Pena Nieto’s party, the Institutional Revolutionary Party (PRI) also changed its internal party constitution to pave the way for reform.

The changes that have occurred over the past two years is due to the reform efforts made in 2007 and 2008. The debates that occurred at that time helped change public opinion, and while Mexicans are still not fully supportive of energy reform, they’re not nearly as opposed to it as they were in 2008. At that time, 80 percent of Mexicans said they opposed opening the nation’s oil and gas sector. In 2013, 60 percent were opposed. Last year, 40 percent opposed, but 20 percent favored opening the sector, and the rest were undecided.

“The issue has not been a popular one, but people are not taking to the streets” over it, said Wood.

The president has staked his legacy on the success of energy reform. Now, he must ensure that Round One is a success, said Wood. If companies look at the data room, set to open Jan. 15, and like what they see, then Round One will be a success. If not, Round One could mark an embarrassing moment for the government.

OIL, GAS COMPANIES CALL FOR MORE FLEXIBILITY IN BIDDING TERMS

Oil and gas companies have called for more flexibility in the proposed bidding terms. Under the current model, a company can’t submit individually or as a consortium member more than one offer for the same contract area. Companies or consortiums may submit bids for no more than five contract areas. Large oil and gas companies with more than 1.5 million barrels per day of production cannot bid together, but this may not apply for other acreage such as deepwater, according to Mayer Brown.

Some companies have said they would rather see limits on the number of blocks a company can be awarded versus a limit on the number of blocks on which they can bid, Wood said. Others want more flexibility in the way that extensions for drilling and field development are made, or would like to see lower fees for data room access and registration. Companies also have voiced concerns over the size of the contract areas offered, the constant monitoring of activity, the strict minimum work commitments and the short-time frame for exploration. The requirement for a company to keep drilling even if they have made a discovery was another concern.

SENER has said that the strict minimum work commitments were implemented to ensure that revenue starts coming in sooner from oil and gas developments rather than later, Wood said. In crafting the bidding terms, Mexico is also seeking to create a transparent process with attractive assets while not appearing to the Mexican public to be giving Mexico’s oil and gas away to the same few subjects that distorted the Mexican oil market in 1938, Wood said.  

Addressing an audience member’s comment on the fees just to pre-qualify and the quality of the resources initially being offered, Wood said that the government is offering low-risk plays with good geology and standard production sharing agreement contracts seen elsewhere. The idea is to ease people into the bidding process.

“The good news is that the Secretaria de Energia de Mexico (SENER) has been responsive to feedback from the private sector, analysts and PEMEX,” he noted.

However, it is under pressure from the Mexican treasury to generate revenues to make up for low fiscal revenues from other areas. PEMEX is also in constant negotiations with CNH and SENER to see what’s in it for them, said Wood. Lay these challenges on top of low oil prices, which strengthens the hands of investors, who have slashed capital spending budgets and have less capital to invest.

“Mexico needs to make sure the terms are attractive and that Mexico looks like a good bet compared with the U.S. Gulf of Mexico and shale plays such as the Bakken,” Wood noted.

POLITICAL CHALLENGES

Pena Nieto and the PRI party’s popularity with voters has waned due to his perceived failure to deliver on campaign promises of better salaries for Mexican workers and stronger economic growth, said Wood. In recent times, the Mexican public – which wants greater prosperity and security against violence – has shown dissatisfaction with how democracy works in Mexico. Over the past 15 years, Mexicans have not really seen much change in their day-to-day life.

“Some parts of Mexico have seen greater prosperity and security, but this has not occurred throughout the country,” said Wood.

Pena Nieto also alienated large portions of middle class voters with a fiscal reform bill passed in late 2013. The bill imposed a number of unpopular taxes in an effort to increase fiscal revenue. One of the stranger taxes imposed was on pet food, said Wood. These fiscal revenues were starting to have an impact in 2014, with growing fiscal revenue that the government planned to use on social programs and infrastructure. However, sliding oil prices hit that revenue, and while the government has partly mitigated the fall with financial hedging.

Wood didn’t have final numbers on the amount of economic growth the Mexico economy experienced in 2014, but the anticipated growth rate of between 2.3 and 2.5 percent will likely disappoint the Mexican public.

“Mexico has really had the worst of both worlds – production slides and low oil prices,” said Wood.

This will not only hit the government, but state energy firm Petroleos Mexicanos (PEMEX).

The government is hoping for a better 2015, but the economic outlook for this year doesn’t look much better than 2014. This means that the government will either have to cut spending plans, or increase the country’s deficit. But foreign investors have warned Mexico against raising the deficit, saying it would take the shine off Mexico in international finance markets.

Pena Nieto also faces challenges in addressing violence in Mexican states such as Veracruz and Tampalinas. The latter state, which has been ripped apart for years by violence, is one of the most important energy states. The comprehensive security plans proposed for both states look solid on paper, but the problems are not expected to go away anytime soon, said Wood.

The current president and his government also have faced criticism for its reaction to the Mexican Army’s massacre of a group of people believed to be associated with organized crime. The disappearance of 43 students in Guerrero also has eroded the public’s perception of Pena Nieto and his government. Pena Nieto will need this year to address with plans to boost economic growth and to address the disappearance of the students.

Mexico also needs to fix its regulatory institutions, including the federal court system, to ensure that its court system will be reliable on matters such as contracts. The justice reform underway since 2008 needs to be fully implemented if the Mexican government is to meet the 2016 deadline for completion.  Efforts to address anti-corruption and increase transparency in Mexico’s regulatory process will need to be priorities this year, said Wood, not just for security, but economic rule of law.

Despite these problems, the fact that Mexican President Enrique Pena Nieto has staked his presidential legacy on the success of energy reform – coupled with the difficulty in reversing the constitution reform – means that energy reform will move forward. The ability of Pena Nieto to get two-thirds majority of both houses of Mexico’s Congress to agree to amend the Mexican Constitution presented a “unique moment” from 2012 to 2014; achieving another supermajority like this would be difficult, making a reversal of energy reform “highly unlikely”.

SHIFTS EXPECTED AS PROCESS MOVES FORWARD

To ensure the success of Round One, Wood expects to see shifts in contract terms as the government realizes it needs to be flexible on issues such as an absence of a cap on royalty payments and limits on the bidding process. Wood also expects to see shifts in the most important element: the timing of the bidding round.

“Everybody sees that it’s an aggressive and ambitious schedule,” Wood said.

With everybody taking longer to make decisions due to lower oil prices and benefits coming in from bidding set to be lower, it makes sense to push the July 2015 due date for bids to the fall, and to take more time to discuss contract terms and strengthen rules to ensure that Round One won’t be a disaster. Final contract terms must be determined by June 14 and submitted a month later; that is not much time for companies trying to put bids together and get internal approval.

Wood echoed an audience member’s comment that Mexico has had many smart people working in the upper echelons of government working on energy reform. But Wood sees the need for the government and private sector to develop the workers needed to fill the lower levels of Mexico’s oil and gas industry.

A disappointing Round One would tarnish the government’s image, but doesn’t change the fact that Mexico has significant, untapped oil resources and that oil and gas development is a long-term decision, Wood concluded.

 

 

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